Chinese manufacturers no longer need infant industry protection

BEIJING – Even as observers in developed countries criticize US President Donald Trump’s use of blunt tools such as tariffs against China, many believe that he is responding to a real problem. China, they argue, really is engaging in unfair trading practices. But is it?

One of the chief complaints against China is that it relies on what US authorities call “forced technology transfer”: foreign companies seeking access to the Chinese market are required to share their intellectual property with a domestic “partner.” But the word “forced” suggests a degree of coercion that does not make economic sense. American and European companies do not have to invest in China; if they choose to do so, knowing that it will require them to share their technology, it is because they still expect to earn a profit.

The technology-transfer requirement should help foreign companies secure better deals with Chinese firms, which will include the technology’s value in their overall appraisal of a foreign investor’s contribution to a joint venture. In exchange, the local partner and local government eager to foster growth would provide cheap land, infrastructure, tax exemptions, or loans on favorable terms.

In short, the transferred technology is priced into any foreign direct investment (FDI). This is reflected in the continued high profitability of companies with foreign investors.

It is only natural that American and European companies declare in surveys that they would be better off had they not been “forced” to transfer their technology. But these statements assume that the terms on which the initial investment was made would be the same without the technology transfer, and that is not the case.

Of course, if technology transfer were not a requirement, the most efficient investment deal in many cases would involve a licensing agreement or the payment of royalties. But that should be only a secondary consideration, because the present value of the foregone licensing fees or royalties would figure implicitly in any investment deal.

But while the costs to Western companies imposed by the technology-transfer requirement are probably being vastly overstated, so, too, are the benefits that the policy brings to China. So why do the Chinese authorities insist on linking market access to technology transfer?

China’s main official argument is that, as a developing country, domestic firms are at a disadvantage vis-à-vis foreign investors, which possess advanced technologies that the local companies do not understand. But while this argument may hold water in some of the less developed countries that use it to justify restrictive FDI regimes, China’s technological capabilities have exploded over the last couple of decades.

In fact, China’s expenditure on research and development is now higher both as a percentage of GDP and in absolute terms than the level in Europe and many other OECD countries. With the country’s capacity for indigenous R&D – not to mention technological absorption – having progressed substantially, there is little need to continue protecting Chinese “infant” industries.

It is this progress that has driven Western companies to become more vocal in their complaints about “forced” technology transfer. Previously, they were more willing to transfer their technology, based on the expectation that Chinese competitors would be unable to adapt and master it, anyway. With China now producing more graduates with bachelor’s degrees in science and engineering than the US and Europe combined, that expectation is no longer tenable.

Despite rising resistance to technology transfer, however, the Chinese authorities remain reluctant to abandon their policy, probably for much the same reason the US is angry: they overestimate its impact. They fail to recognize that Western companies might be offering worse terms to Chinese partners than they would if they could keep their technology and use licensing agreements instead.

Yet these other forms of technology transfer are already becoming increasingly prevalent: recorded royalties payments from China have skyrocketed, and now amount to close to $30 billion per year. With China now second only to the US in terms of paying for foreign technology, it is clear that a large and growing share of technology transfer is not “forced.”

For Trump, however, that may not be the point. What his administration is really worried about is that China is about to surpass the US and lock down technological leadership in a number of sectors considered critical for national security (on both sides of the Pacific). Yet forcing China to eliminate its technology-transfer requirements will not change this.

An end to that policy may actually be in China’s best interests. The US and China account for a large share of global trade, but they do not dominate the global economy. The bilateral trade war will be won by the side that can gain the support of the neutral powers (such as Europe and Japan) by appearing more reasonable. For China, this would mean abolishing all restrictions on foreign ownership, including the requirement that technology be shared, rather than licensed.

Such a move would underscore the strength of the Chinese economy, without costing China nearly as much as its leaders or US policymakers seem to think. Perhaps more important, it would force the US either to stop its China bashing or to admit that the underlying motivation is not economics, but geopolitical rivalry.